What to watch this week

The Federal Reserve triggered an ‘everything rally’ last week after their dovish pivot on Wednesday. The S&P 500 rose more than 2.7% over the week, the Nasdaq was up more than 3%, as the expected cut to US interest rates benefitted growth stocks the most. European indices did not get in on the act, as the Bank of England and the ECB both pushed back against market expectations of interest rate cuts. The Dax, which recently reached a record high, fell by 0.8% over the week, while the Cac 40 in France eked out a measly 0.1% gain. The dollar index fell further and was down 1.5% over the week, while EUR/USD edged towards $1.10 and was higher by 1.4% over the week. As we move into the last main trading week of the year, some new themes are developing, which will shape trading for 2024.

Can the BOE and ECB maintain their “hawkish” stance?

The key theme to watch is the divergence between the major central banks. If you were to guess how central banks would react based purely on the economic data, you would have thought the ECB and BOE were more likely to talk dovish at this meeting. At the start of this week, the FT’s front page screams another warning about the economy, reporting that corporate bankruptcies in the UK are increasing at double digit rates. In fairness, the FT is claiming that bankruptcies are soaring all over the world, but the UK is seeing the third largest, according to the OECD, behind Sweden and Denmark, and insolvencies in England are now at their highest levels since 2009. However, the BOE, while acknowledging the challenges facing the UK economy seem unwilling to share the same tone as the Federal Reserve and instead are sticking to the higher for longer mantra. This divergence has halted UK and European stocks from joining in the rally that has caused US stocks to surge. For example, the UK’s FTSE 100 is up only 1.97% YTD, while European and UK bond yields also ticked higher, and the pound and the euro were both higher vs. the USD.

But should we even listen to the ECB and the BOE, since history teaches us that the main central banks follow the Fed anyway? The BOE and the ECB’s rebellion against the Fed may be difficult to sustain. In February and March the BOE and the ECB will update their forecasts for growth and inflation. These updated forecasts are likely to reflect recent economic weakness, including a shock negative GDP report for the UK in November and weak Eurozone inflation. At that point, the BOE and the ECB may have run out of hawkish road, which may have big implications for their currencies, and could give the UK stock market a welcome boost.

The Magnificent 7 lead the way

There is also a question about how long the “everything rally” can last. While everything in the US is rallying, that is not the case in Europe right now, which could leave valuations more attractive this side of the Atlantic, as we move forward, especially if the ECB and the BOE join the Fed and pivot to a more dovish stance. However, after Wednesday’s pivot, it is worth noting that the IT sector in the S&P 500 rose to a record high, and it is once again the Magnificent 7 tech giants that are lifting US indices. Big tech stocks have jumped on average 75% this year and now make up 30% of the S&P 500. The other 493 stocks in the S&P 500 have risen by a more modest 12% on average, which is still significantly more than stocks on the FTSE 100. The resurgence of tech suggests two things: 1, the S&P 500 is no longer an index that represents a broad group of companies, and 2, does that even matter, when the combined weighting of the magnificent 7 on the MSCI All Country World Index is larger than all of the stocks from Japan, France, China, and the UK? Can anything challenge the Magnificent 7, and is there anything that could stop them in 2024?

Can the tech rally last in 2024?

After tech slumped 40% in 2022, the AI boom has fuelled the rally in 2023, and that is likely to be a multi-decade theme. We have said in previous notes, that the path of least resistance for investor exposure to AI is Nvidia and Microsoft, two of the Magnificent 7, and this could continue into 2024. However, it is worth noting that not all of the Magnificent 7 are created equal, and within this select group there are varying performances, for example, Amazon, Tesla, Meta, and Alphabet are trading below their 2021 peaks. Does this mean that there is an opporyniuty for these Mag 7 stocks to play catch up to the likes of Apple, Nvidia and Microsoft next year? Or will extremely high valuations mean that sectors like industrials and materials, which have seen more modest performances this year, dominate in 2024? With an economic slowdown ameliorated by potential Fed rate cuts, this can’t be ruled out.

Bank of Japan watch

Elsewhere, the one central bank that is expected to diverge from the Fed is the BOJ. It will conclude its meeting on Tuesday, and it is expected to keep rates steady. However, this meeting will be a major test of the new BOJ Governor Ueda’s communication skills, as he tries to prepare the markets for the end of negative interest rates, while at the same time to dampen down any expectation that such a move is imminent. Thus, any tweak to his guidance could be subtle and we believe that the focus of BOJ communication is to avoid surprises, which is the exact opposite of what the Fed did last week. Inflation in Japan has been above the 2% target for most of 2023, and the market now expects a rate hike from the BOJ in April. Some expect January, but we think that this is too soon. Before the BOJ hikes interest rates, we expect them to state that inflation pressures are building within the Japanese economy, from wage growth etc, rather than from supply issues that are global. If he says that in Tuesday’s press conference, then it could signal an earlier rate hike. If he maintains that inflation pressures are caused by global forces, then a rate hike is likely not on the cards in the near future. Either way, USD/JPY will be in focus, this pair is down more than 2% over the last week, and we expect to see further declines back towards Y140.00 if the BOJ’s communication is deemed hawkish later this week.